It’s worth keeping the efficient market hypothesis in mind when considering the impact of Fed Chairman Ben Bernanke’s announcement this week that bond buying will be coming to an end.
The efficient market hypothesis suggests that share prices always incorporate and reflect all relevant information. While the hypothesis may be flawed, it should be no surprise that markets react to information, and that the announcement itself would have an impact, even though no one knows for certain when quantitative easing (QE) will end or when “tapering” or bond purchases will begin.
The price of a security at any given time reflects not only the performance of a company in the context of overall market conditions, but future expectations. So markets panicked because the Fed chief acknowledged the obvious – that QE will be ending someday.
Today’s Dow Jones Industrial Average.
Other than admitting the obvious, The Fed’s comments were inconclusive, with plenty of “ifs,” “ands” and “buts,” and the market performance has been similarly inconclusive, jumping up and down enough to make investors seasick.
Today’s S&P 500 Index.
That queasy feeling is caused by volatility, which we discussed last week.